OFF 1-STEP CLASSIC
OFF ALL CHALLENGES
In the financial markets, there is usually the tendency to rely on a single piece of information to make a trading or investment decision. In most cases, the buying and selling that takes place is anchored on a single piece of information, regardless of whether it needs to be updated or corrected. Such kind of behavior is often dubbed as anchoring bias.
Anchoring bias is a behavior or tendency whereby traders place importance on the previous price or the first piece of information they receive to make decisions. As a result, the information is relied upon regardless of being correct or incorrect, often exposing traders to significant risks. In this case, the anchor information acts as the reference point from which future decisions are made.
Therefore, it prevents people from making informed or rational decisions whenever certain data points change, or new information exists. In the investment world, anchoring leads to traders chasing trades.
Source: Pinterest
An anchoring basis also causes investors and traders to make bad decisions and chase first investments rather than looking for better alternatives. The cognitive biases also make adapting to the changing market environment challenging.
In trading, anchoring bias takes many forms.
Consider a trader who opens a buy contract on the S&P 500 Index at the start of a trading day on the market showing signs of edging higher. The trader holds the position based on the information used at the beginning of the trading day, regardless of what transpires in between. Even on the market showing signs of exhaustion and potential reversal, the trader refrains from selling the contract as their beliefs and decisions are anchored on the initial information about a bullish run and don’t wish to consider anything else.
Another trader buys Tesla stock based on price hikes and the belief that the company is poised to dominate the electric vehicle space for many years to come. Given that the trader is anchored on previous performance expectations and price hikes, they would be reluctant to sell even if the price starts to tank. Changing market trends and increasing competition in the EV space don’t sway the trader to exit the market as their trade is anchored on the previous information.
Studies have shown that the human brain tends to anchor new information as it makes it easy to make decisions. Therefore, traders make trading or investing decisions based on the anchor information imprinted in their brains.
In most cases, anchoring bias in trading causes traders to use first impressions to make decisions or form further perceptions. Therefore, it might be found at any point in the trading decision-making process.
Source: CMT Association
Anchoring bias affects trading in various ways. First, it could lead to emotional attachment to prior prices or positions. In this case, one would make buy or sell decisions based on past prices.
Suppose a trader is strongly convinced that a given stock's price should be $200 based on previous information. In that case, they will make a buy decision after a significant sell-off, even if underlying metrics indicate the stock is overvalued.
Similarly, a trader may open a sell position on a stock if they strongly believe it should trade at $200 after a significant price increase. The trader would open a sell position even if current metrics and fundamentals indicate it is still undervalued, as the focus is on previous information rather than new data.
Despite the significant risks anchoring bias presents, it happens daily, affecting professional and novice investors and traders equally. The bias occurs due to the following:
Whenever traders are under immense pressure and time constraints to make investment decisions, most base their decisions on previous data. Traders rely heavily on initial prices and data instead of conducting in-depth analyses and analyzing current fundamentals. The anchoring bias may result in the traders making incorrect decisions that hurt their portfolios.
Anchoring bias may also come into play in the absence of new information that traders can use to make informed decisions. Consequently, traders need to adjust their valuation based on new information, Such as changing market conditions. Instead, trades and investments are made based on the initial price that acts as the anchor or strong convictions.
It’s the tendency to seek and rely on information to confirm existing beliefs. Ultimately, trades are made based on this information, which is extremely biased. Therefore, ignoring information that contradicts existing beliefs presents significant risks when it comes to making decisions.
One of the biggest risks in trading is having an emotional attachment to a given stock or an underlying price. The attachment often leads to anchoring bias as decisions would be made based on previous experiences and prices rather than current information. For instance, a trader may be unwilling to close a position even on new information implying they should because they have an emotional attachment to the previous price. Consequently, traders should always watch out for fear, greed, and regret, as they can lead to anchoring bias.
Anchoring bias presents significant risks when trading the financial markets. Any trading decisions should be based on current information and not anchored on previous data or prices. While it can be challenging to avoid anchoring bias, one can do a few things to avoid its pitfalls.
Source: Youtube.com
First, it is important to acknowledge anchoring bias by asking questions to ensure decisions are not emotionally driven or based on previous information or data. Always consider all available information and options while trying to buy or sell.
While making trading decisions, it is essential to consider all alternative scenarios rather than being fixated on a particular reference point. In addition, seeking and analyzing diverse sources of information rather than relying on one data point could also help avert the anchoring bias risk.
Additionally, traders must resort to rule-based trading rather than making impulsive or irrational decisions. Finally, diversifying an investment portfolio helps avoid becoming too attached to a given investment or position.
Making a living trading futures is no easy task. Most traders fail. So it’s understandable if you feel overwhelmed, even intimidated, by the prospect of prop trading. After all, prop trading isn’t just a different way to trade futures. It’s a different ball game with other rules, cultures, and objectives. Learning how to become a […]
For many traders, options can seem complicated and overwhelming. As a result, many aspiring prop traders shy away from options altogether and miss out on lucrative opportunities. How to Become a Prop Trader is a question often overlooked when navigating the complexities of options. Picking the best prop firm for options trading can help you […]
Imagine pouring hours of effort into your trading skills only to realize you've hit a wall once you feel ready to go pro. The truth is that trading is an incredibly competitive field, and most independent traders fail to make it on their own. If you’re looking for an alternative to trading alone, stock prop […]
Forex prop trading firms are valuable resources for aspiring traders. If you want to learn how to become a prop trader, you’ll quickly discover the significance of these specialized firms and what they can offer your trading journey. For instance, prop firms provide access to trading capital, which lets you skip the slow process of […]
You’ve learned the basics of trading futures. Now you’re ready to take your trading career to the next level. Prop trading firms are an exciting way to achieve that goal. With a focus on futures prop trading firms, this article addresses how to become a prop trader, the benefits of joining a prop trading firm, […]
Trading can be challenging, especially for new traders trying to figure out how to become a prop trader. You might feel overwhelmed by the sheer number of prop firms out there. How do you find the one that fits your needs? To help you on your journey, this article identifies the best prop firms for […]
Many aspiring traders dream of waking up and logging into their trading platform to begin their day. However, many traders don’t realize that achieving this success level takes time, effort, and funding. In many cases, traders improve their performance and succeed with the help of proprietary trading firms. You'll likely encounter a few proprietary trading […]
Becoming a proprietary trader is an excellent way to kickstart your career as a trader. Prop trading firms provide traders the capital to trade larger accounts while offering various support tools and resources to help them succeed. While many prop trading firms exist, not all offer the same benefits. Some are much better than others. […]
Prop trading appeals to many aspiring traders because it allows them to trade with a firm’s capital while sharing a percentage of the profits. While this sounds promising, prop trading is not as easy. You can’t just join a prop firm, start trading, and expect to make money fast. Like all trading endeavors, prop trading […]
Imagine this: you have been trading crypto on your own for a while now, and while you're making progress, you're still not where you want to be. The risk of trading is still daunting, and even though you have a strategy that helps you confidently make trades, there is still that nagging anxiety about the […]
Starting your prop trading career at a firm that aligns with your skill level and goals can make all the difference. For example, if you’re struggling with the inherent risks of trading, a firm with an easy and low-pressure onboarding process can help you ease into prop trading. On the other hand, if you’re an […]
Imagine working long hours, only to achieve minimal results with your trading. This is true for many independent traders who lack the capital and resources necessary to trade effectively. Prop desk trading offers an alternative solution. By joining a proprietary trading firm, you can quickly access a large trading account and achieve your financial objectives […]
